The New Economy and Information Revolution

The New Economy was the name given in the 1990’s to the idea that there had been an evolution in the United States and other developed countries from an industrial/manufacturing-based wealth producing economy into a service sector asset based economy (The New Economy). It was assumed that a permanent change in the economic structure of the U.S had taken place and that technology was spurring growth so dramatically that traditional assumptions about productivity, inflation, profits and so on no longer hold (Lock and Key). Furthermore, it was believed that the change rendered obsolete many standard business practices (The New Economy, Varian et al. 12).

During the 1990’s the United States economy was booming. Inflation and unemployment were low and output was high. After advancing at 1.5% per year for more than two decades, productivity growth soared to an average of 2.5% a year in the late 1990s (Making Less With More). During the same years, US companies nearly doubled their pace of Information Technology (IT) investment. Many observers linked these trends and concluded that IT caused an increase in labor productivity throughout the economy (McKinsey & Company, Varian et al. 3).

The key economic component to the “New Economy” is this increase in productivity. Productivity growth is likely considered the single most important indicator of an economy's health: it drives real incomes, inflation, interest rates, profits and share prices (Economic Focus-A Productivity Primer). GDP represents the quantity of the labor and capital resources used in production and their productivity, plus the productivity with which these resources are organized in the workplace (multi factor productivity). Faster growth in productivity allows faster growth in GDP with low inflation. This, in turn, boosts profits and share prices and encourages more investment, which further lifts productivity (Productivity, Profits, and Promises). The focus on productivity runs deep. Economists care because productivity gains are linked to rising standards of living; investors care because those living standards translate into higher consumption, profits and share prices (Another Look at Productivity). Due to the power of compounding, tiny swings in productivity percentages can have a big impact.

When the dot-com stock market bubble burst, the assumptions mentioned previously were called into question. Many of the more exuberant predictions proved to be wrong and it was argued that the productivity gains experienced were not due to investment in information technology. Indeed, some lines of research suggest that IT investment was only one of several factors at work. Innovation (including but not limited to, IT and its applications), competition, and to a lesser extent cyclical demand factors, were important causes (McKinsey & Company). However, many economists agree that the stronger productivity growth during these years was due to investment in Information Technology (Computing the Gains, Varian et al. 11).

Since the dot-com bubble burst however, productivity rose to over 3% a year between 2002 and 2004. Currently, the consensus among academic experts seems to be that America's trend rate of productivity growth is below the pace of 2002-04, perhaps slightly lower than in the late 1990s, but well above the 1.5% average of the previous two decades. Some researchers estimate productivity growth is around 2.25% (Making Less With More). The fact that productivity growth uncharacteristically continued to grow during the subsequent slump is curious. Information Technology undoubtedly it played a role, though there will continue to be debate on how important it has been (Varian et al. 11).